Summary
- Comstock Resources is an independent E&P focusing on the production of natural gas in the Haynesville Shale.
- The high quality of the company's acreage allows it to produce natural gas for an incredibly cheap price and at very high margins.
- The company is very well positioned geographically to become a major supplier of natural gas to the rapidly-growing liquefied natural gas industry.
- The company has been making a lot of progress at getting its debt under control, although it is still a bit higher than I really like to see.
- Comstock Resources boasts an attractive valuation relative to its peers.
Comstock Resources, Inc. ( CRK ) is an independent exploration and production company that focuses heavily on the production of natural gas. This is generally a good place to be as the long-term fundamentals of natural gas are quite powerful. This is reflected in Comstock Resources' stock price, which is up 55.61% over the past year. Fortunately, it appears that the future of natural gas is quite strong and that positions Comstock Resources for fairly strong growth over the coming years. Despite the strong appreciation that the stock has already benefited from though, the company still appears to be fairly dramatically undervalued at the current price so there is still plenty of time for an investor to jump in. When we combine this attractive valuation with the company's strong balance sheet and forward growth prospects, we have the makings of a very appealing opportunity that is worth considering.
About Comstock Resources
As stated in the introduction, Comstock Resources is an independent exploration and production company that focuses primarily on the production of natural gas. This is something of a rarity in the energy sector as very few independents focus exclusively on this area. The ones that do tend to operate in the Appalachian region, such as Range Resources ( RRC ), EQT ( EQT ), and Antero Resources ( AR ). Comstock Resources is different though as it operates in the Haynesville Shale. The company owns a substantial 372,000 net acres in this basin:
Comstock Resources
The Haynesville Shale is a basin that may not be familiar to all readers. However, it is considered to be the second-largest natural gas deposit in the United States. According to the U.S. Energy Information Administration , the basin has proven reserves totaling 29.5 trillion cubic feet of natural gas, a figure that is second only to the Marcellus Shale. This resource wealth is reflected in Comstock Resources' reserves as the company currently has 25 years of drilling activity based on its 2022 well program.
A company's reserves are something that is often overlooked by investors to their detriment. This is because of the importance of a firm's reserves. After all, the production of crude oil and natural gas is by its nature an extractive process. The companies that produce these resources literally obtain them by pulling the hydrocarbons out of reservoirs located in the ground. As these reservoirs only contain a finite quantity of resources, companies need to ensure that they have sufficient reserves on hand to maintain their production over an extended period just in case they fail to discover or otherwise acquire more. Thus, it is quite nice to see that Comstock Resources has enough resources in the ground to maintain its drilling activity at the current level for another 25 years. This somewhat reduces the pressure on the company to continually acquire new sources of these resources.
Another major advantage that the high quality of the company's acreage provides to Comstock Resources is that it can produce natural gas for one of the lowest costs in the industry. In fact, it only costs the company $0.74 to produce 1,000 cubic feet of natural gas equivalent, which is one of the lowest prices in the industry:
This provides two advantages to Comstock Resources. One of these is that the company is protected against declines in natural gas. As the company can produce natural gas for only $0.74 per thousand cubic feet equivalent, natural gas prices can fall substantially from today's price of $5.18 per thousand cubic feet and Comstock Resources will still be able to turn a profit. It is highly unlikely that natural gas prices will ever fall to that level again, although we might see further short-term declines. One reason for a potential short-term decline is economic problems in the United States. During both the first and second quarters of 2022, the United States posted a decline in its gross domestic product. As I discussed in a recent article , it is quite likely that we will see a decline in the third quarter as well. Thus, the United States is in a recession by any definition. One thing that we frequently see in recessions is a decline in energy prices because of a decline in demand. This may happen again in the near future and indeed we did see natural gas prices decline very rapidly over the past week. This recession may be different though since the natural gas export market is now stronger than ever.
The second major advantage that a low cost of production provides to Comstock Resources is that it enhances the company's margins. Comstock Resources has a phenomenal 85% EBITDAX margin, which is the highest of any producer in either in Bakken Shale or the Permian Basin:
This means that the company has more money available to use for shareholder-friendly purposes such as paying down debt, buying back stock, or paying a dividend. Admittedly, the company does not currently pay a dividend despite this, which is quite disappointing. However, it may start at some point considering that its free cash flow for the first half of 2022 is up 586% versus the comparable period in 2021. This is despite the fact that the company's production was actually down slightly over the same period of time.
Comstock does appear likely to grow its production in the second half of the year, although likely not by very much. The company has guided for an average 2022 production rate of 1,390 to 1,450 thousand cubic feet of natural gas equivalent per day over the course of 2022. This is a bit higher than the 1,369 thousand cubic feet of natural gas equivalent per day that the company produced on average during the second quarter. Thus, if this guidance is to be reasonably accurate, the company must increase its production during both the third and fourth quarters sufficiently to bring this average up. When we consider the company's very low costs of production, it seems likely that it can accomplish this despite the declining natural gas price that we saw over the past week or so. This could have a positive impact on the company's profits and free cash flow over the remainder of the year as well. After all, increasing production gives the company more resources that it can sell for revenue so that should result in rising revenue and by extension profit all else being equal. Of course, all else is rarely equal and natural gas prices at Henry Hub are down 23.1% over the past week. As Comstock Resources has less than 50% of its expected production for the second half of 2022 covered by hedges, this could potentially offset the impact of higher production.
In a few recent articles, I discussed the very strong growth prospects for liquefied natural gas. This is coming about due to a combination of factors including the world, in general, attempting to move away from coal and other heavily-polluting forms of energy and the sanctions that the various Western nations have put on Russia. These factors have all caused the United States to become a very significant exporter of natural gas but the only easy way for the country to export the compound to any nation except Mexico is by converting it into a liquid. As we can see here, liquefied natural gas exports reached a record 11.9 billion cubic feet of natural gas per day this year:
Comstock Resources
This industry is expected to continue to grow dramatically over the next decade as both Europe and Asia seek to increase their imports. In fact, Asia is expected to boost its imports of liquefied natural gas by 40% between now and 2030:
Golar LNG
Comstock Resources is very well positioned to take advantage of this, which could ultimately prove to be a growth opportunity for the company. This is partly because of the company's geographic location. The majority of liquefied natural gas plants in the United States are located along the Gulf Coast in either Texas or Louisiana. The Haynesville Shale in which Comstock Resources operates is located in East Texas, Louisiana, and Arkansas. This positions Comstock Resources' operations very close to the plants that are converting natural gas into a liquid state. This is advantageous to Comstock Resources because it will be much cheaper and more convenient for it to transport its natural gas to many of these plants than it would be to transport natural gas from Appalachia the whole way down to the Gulf Coast. As the plants that are currently under construction will require approximately eight to ten billion cubic feet of natural gas per day, it should be fairly easy to see how enormous an opportunity this could be for Comstock Resources considering that this demand is a multiple of its current production.
Financial Considerations
It is always critical to analyze the way that a company is financing its operations before making an investment in it. This is because debt is a riskier way to finance a company than equity because debt must be repaid at maturity. As few companies have sufficient cash on hand to completely pay off their debt as it comes due, this is usually accomplished by issuing new debt and using the proceeds to pay off the maturing debt. This can cause a company's interest costs to increase following the rollover, depending on the conditions in the market. In addition to this, a company must make regular payments on its debt if it is to remain solvent. Thus, an event that causes a company's cash flow to decline could push it into financial distress if it has too much debt. This could be an especially big risk for an energy company like Comstock Resources because of the overall volatility of commodity prices.
One metric that we can use to judge a company's debt load is the leverage ratio, which is also known as the net debt-to-EBITDAX ratio. This ratio essentially tells us how long it would take the company to completely pay off its debt if it were to devote all of its pre-tax cash flow to that task. Currently, Comstock Resources has a leverage ratio of 1.2x based on its trailing twelve-month EBITDAX. This is a reasonable ratio, although many of the company's peers have a ratio of less than 1.0. Comstock Resources has been working to get down to that level though as its ratio was at 2.9x at the end of the second quarter of 2021. This is one of the reasons why Comstock Resources is not paying a dividend despite its robust free cash flow. The company has instead opted to focus its efforts on debt reduction. This could prove to be a smart decision if natural gas prices fall further and the country descends into a recession. The company's ratio is not bad right now but admittedly it would be nice to see it get this figure down under 1.0x as some of its peers have already done.
Another nice thing about Comstock Resources' debt is that the company has very limited near-term maturities. In fact, it has only $350 million worth of debt coming due prior to 2029:
Comstock Resources
Upon seeing this chart, some readers may point out that the company has a $1.4 billion revolving line of credit coming due in 2024. While that is true, only $350 million is actually outstanding so that is the amount that Comstock Resources actually has to come up with. This is not an amount that the company should have any problem coming up with by that time so it is nothing to worry about. We can see that the company does have a significant amount of debt maturing in 2029 and 2030, however. The fact that those debts do not mature for many years is fairly comforting though since it means that Comstock Resources still has a considerable amount of time to come up with the money to cover them. When we consider that the fundamentals for natural gas are incredibly strong over the next decade and Comstock Resources' growth potential because of these fundamentals, this debt should likewise not pose much of a problem. Overall, the company's financial structure appears reasonable, especially if the company keeps up with its debt reduction efforts.
Valuation
It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to generate a suboptimal return on that asset. In the case of an independent exploration and production company like Comstock Resources, we can value it by looking at the forward price-to-earnings ratio. This ratio tells us how much we are paying today for each dollar of earnings that the company will generate over the next year.
According to Zacks Investment Research , Comstock Resources has a forward price-to-earnings ratio of 4.32 at the current stock price. That is incredibly cheap in today's market, which tends to see most companies having a ratio well into the double digits. However, as I have pointed out in a number of previous articles, pretty much everything in the traditional energy industry is incredibly overvalued today. Thus, it may make sense to compare Comstock Resources to some of its peers to see which company offers the most attractive valuation today:
Company | Forward Price-to-Earnings |
Comstock Resources | 4.32 |
Range Resources | 4.85 |
Antero Resources | 5.17 |
EQT Corporation | 8.19 |
Chesapeake Energy ( CHK ) | 5.86 |
(all figures courtesy of Zacks Investment Research)
As we can clearly see, Comstock Resources has by far the most attractive valuation here, although none of these companies is particularly expensive. Thus, it does appear that Comstock Resources is giving investors a very attractive proposition right now.
Conclusion
In conclusion, there appears to be a great deal to like about Comstock Resources right now. The company is generating significant amounts of free cash flow right now by virtue of its strong margins. This has allowed it to aggressively pay down its debt, which it will likely continue to do for a few more quarters before reinstating its dividend. The company is also well positioned for growth due to the impressive fundamentals for natural gas over the next decade, including from the rapidly growing liquefied natural gas space. When we combine all this with a respectable balance sheet and an incredibly attractive valuation, we have all the makings of a great investment opportunity.
For further details see:
Comstock Resources: Attractive Valuation And LNG Growth Potential